Electricity prices are hitting record highs across Europe, slamming people with higher power bills and putting politicians on the spot.
The numbers are shocking. In Spain and Portugal, average wholesale power prices are around triple their level half a year ago at €175 per megawatt-hour. In the U.K., they've reached an eye-watering €183.84 per megawatt-hour — now the most expensive rate in Europe.
Politicians are rushing to protect industries, and especially consumers, from higher bills.
Spain's government last week unveiled a "shock plan" to slash taxes on power bills and claw back funds from utilities to protect retail buyers. France is trying to protect poorer consumers. U.K. Business Secretary Kwasi Kwarteng told people not to "panic," promising the government would avoid a crisis. Greece and Italy have their own emergency plans.
The short answer as to why power prices are so high is they're piggy-backing on soaring natural gas prices, used across Europe to generate a key percentage of electricity. But the story is more complex, involving issues of power market design, long-term climate strategies and a bit of bad luck. POLITICO took a look at what's driving the surge.
Gas has a lot to do with it
Natural gas is a crucial part of much of the Continent's energy mix.
This dependence is a big problem in most countries, as prices are skyrocketing. Prices on the Dutch TTF gas hub were €74.15 per megawatt-hour on Tuesday, four times higher than in March.
The numbers are up due to a recovery-related surge in demand and low supply. Europe has also been affected by Moscow's decision to cut back on gas shipments across Ukraine (it booked no capacity on Ukrainian pipelines for October). With lower-than-normal deliveries, Europe's gas reserves — used to store up supplies for the winter — are much lower than usual.
The International Energy Agency on Monday called on Russia to boost its gas exports to help with the crunch. "The IEA believes that Russia could do more to increase gas availability to Europe and ensure storage is filled to adequate levels in preparation for the coming winter heating season," it said.
EU lawmakers have called for the European Commission to open an investigation into “possible deliberate market manipulation” by Russia’s state-owned Gazprom.
The U.K. is particularly exposed after the closure of its Rough gas storage facility, leaving it with little ability to store extra gas to ride out a supply squeeze.
Europe is also competing with Asia for supplies of liquefied natural gas, meaning there's not much spare capacity.
Why renewables can't fill the gap
In 2020, renewables generated 38 percent of the bloc’s electricity, overtaking fossil fuels to become the leading source of power in Europe for the first time ever. But wind and solar power are incapable of generating enough power to account for 100 percent of demand year-round, even in the most favorable climate conditions.
The phaseout of nuclear in countries like Spain and Germany, which have set national targets for winding down their existing nuclear fleets, also increases the gap between consumer demand and the electricity supply that can be generated by renewable sources.
A touch of bad luck
Imported power accounts for about a tenth of the U.K.'s market. Last week, a fire at the IFA interconnector site in Sellinge shut down a key power link with France, reducing the amount of power available on the market.
In recent days, Northern Irish system operator SONI closed the Moyle link to Scotland to exports because of its own supply concerns. Maintenance on the U.K's North Sea gas wells has also cut production, according to S&P Global Platts.
And despite having Europe's largest onshore gas field, the Netherlands said it has no plans to boost production at its Groningen field, which is being phased out over earthquake fears.
A market design problem
EU countries trade electricity on wholesale markets where the goal is to cover the energy demand for every single hour of the following day.
The markets follow a marginal model, which means the final price of electricity for the following day is pegged to the price of the most expensive fuel required to meet projected demand. The system is designed to provide utilities with the opportunity to recover investments and operating expenses.
If 100 percent of demand can be met with wind, solar and nuclear, which have very low generation costs, the price of power can be very low or even negative — this happened during the spring of 2020, when electricity demand was low and renewable energy production was high.
But when the expected demand exceeds the supply capable of being generated by clean power, costly fossil fuels have to be used to meet demand, and the price of power is pegged to that value. That's why the spike in natural gas costs is bad news for power prices.
The Spanish government on Monday urged the Commission to rethink the wholesale electricity market.
"In the last three years, we have halved the emission intensity of our generation mix and strongly reduced the participation of fossil fuel power plants," Madrid wrote in a paper sent to Brussels. "However, fossil fuel plants still set the price and are behind the sudden increase in the cost of electricity."
The Commission has heard such appeals in the past — and rejected them. A spokesperson said last month the current system “ensures cost-effective flow” and promotes the “protection of vulnerable consumers.”
Experts agree with the Commission. Alternate setups, such as pay-as-bid models, have actually led to higher prices in places they’ve been implemented.
Is it the fault of the Emissions Trading System?
There's much talk of the EU and U.K. cap-and-trade carbon systems being linked to the current power price surge, but it's not a key factor in what's happening.
The ETS is designed to set a price on greenhouse gases and help drive decarbonization. For years, the EU ETS stalled at around €5 a ton, but a series of market reforms and a growing push to act on climate change has sent prices spiraling. They're now about €60 a ton.
The price jump is attracting speculators. Spain this week called on the European Commission to step in to prevent such activity, echoing similar calls from Warsaw.
ETS prices are expected to rise even higher, leading to a lot of concern about future power price hikes in countries like coal-dependent Poland, but it's not a big cause of the current spike. Countries such as Germany have even found it cheaper to burn coal rather than use expensive natural gas to meet power demand.
What happens next?
With winter approaching, the outlook isn't good for any quick end to the price increases.
"Going forward, the European gas market could well face further stress tests from unplanned outages and sharp cold spells, especially if they occur late in the winter," the IEA said.
The big question is whether the current price spikes are a temporary phenomenon linked to a series of one-off events or signs of a deeper problem as the EU undergoes an energy transformation. It's a tricky one to answer, as all the parts aren't yet in place for a low-carbon power system.
"The energy supply-demand balance in the EU will be volatile depending on how quickly fossil fuels are phased out and green energy is phased in," said a study by the think tank Bruegel.
In the longer term, building up the EU’s renewable energy capacity is likely to help the bloc meet demand with clean and cheap energy sources. But because of the marginal market system, and until large-scale batteries are developed to store renewable energy when weather conditions are unfavorable, EU countries will continue finding themselves dealing with similar situations.
The storage capacity needed to resolve the issue isn't expected to be installed in the EU until the latter half of this decade.
“Well-managed, clean energy transitions are a solution to the issues that we are seeing in gas and electricity markets today — not the cause of them,” said IEA Executive Director Fatih Birol.
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